By Sam Stovall The industries in my High Momentum List -- consisting of those S&P 1500 subindustry indexes with trailing 12-month price performances that are in the top 10% of all 123 subindustries in the S&P Composite 1500 Index -- hasn't seen much turnover recently, or at least not enough to offer me an effortless way to identify industries to write about on a weekly basis. Therefore, every so often, I go out searching for other industries to highlight. This time, I've decided to seek a little help from the STARS.
No, I'm not an astrologer. I'm talking about S&P's Stock Appreciation Ranking System, or STARS, in which S&P's 66 U.S. equity research analysts establish buy, hold, and sell recommendations on more than 1,500 stocks for the coming 12 months. A stock with 5 STARS is ranked strong buy, while 3 STARS means hold, and 1 STARS indicates strong sell. (See the glossary and disclosure statement at the end of this report for a more complete description.)
MERGING METRICS. I decided to combine industries' market-cap weighted average STARS ranking along with our 12-month
Relative Strength Ranking (RSR) metric. The list below shows the 10 top industries, based on two criteria:
1. The trailing 12-month RSR has to be in the top 30%, as indicated by an RSR score of 4 or 5
2. The industry's market-cap weighted average STARS has to be above the average of 3.7 for all stocks in the S&P 1500.
S&P 1500 Sub-Industry
Distillers & Vintners
Integrated Oil & Gas
Investment Banking & Brokerage
Managed Health Care
Oil & Gas Drilling
Oil & Gas Exploration & Production
Oil & Gas Refining & Marketing
When I saw the list, one thing jumped out at me right away: Oil and gas groups remain favorites from a fundamental and momentum standpoint. To find out why, I checked with the S&P analyst who follows one of the energy groups on the list: Stewart Glickman, S&P's oil- and gas-drilling analyst.
According to Glickman, S&P's fundamental outlook for the oil- and gas-drilling subindustry is positive. S&P's outlook is based on anticipated favorable industry conditions and its view that capital spending will remain high, particularly in international regions with low-cost drilling opportunities.
DAYRATES GOING UP. Onshore North America, which has seen a marked increase in rig activity over the past 18 months, is witnessing a scarcity of available equipment, which should bolster dayrates (the sum paid to a drilling contractor for each 24 hours of operation under contract), says Glickman, although the pace of new land rig construction appears to be accelerating.
In the Gulf of Mexico, S&P expects an uptick in dayrates based mainly on tight supply, which has been exacerbated by severe damage to 11 mobile drilling rigs caused by Hurricanes Katrina and Rita, and which should be heightened over the next three months as seven additional rigs are mobilized out of the Gulf to international regions, more than offsetting two other rigs that are returning to the Gulf shortly. Markets for semisubmersible rigs (floating offshore drilling units whose pontoons and columns, when flooded, cause the unit to submerge to a predetermined depth) continue to improve, with recent contracts at extremely high dayrates.
Internationally, supply/demand fundamentals appear to S&P to be very strong in West Africa, Southeast Asia, and the North Sea, where Glickman thinks demand could exceed supply by mid-2006 for both jackups (mobile offshore drilling rigs) and semisubmersibles. An expected influx of jackup rigs to the Middle East should mitigate some of the surplus demand in that region to some extent, but S&P sees potential for further demand increases there.
HOT DRILLS. Over the longer term, S&P expects demand for contract drilling to increase. In the U.S., Glickman believes high field depletion rates and increasing demand for natural gas will continue to support healthy drilling activity both on- and offshore. Internationally, S&P expects additional spending by major oil companies, as well as by state-owned ones, to be the main growth driver as they continue to search for low-cost drilling opportunities, mainly in new regions around the world.
The number of rigs either under construction or on order has increased to about 58, including 43 jackups, although only 11 of those are slated for delivery by early 2007 -- and some of them do not yet have contracts in place. However, some of these rigs are being built without contract commitments in place, so it remains to be seen how quickly they will become operational.
Energy prices should remain elevated, which should support drilling activity, in S&P's view. As of early December, forecasting outfit Global Insight projected West Texas Intermediate oil prices averaging $56 per barrel in 2006, with Henry Hub natural gas prices averaging $9.34 per million British thermal units.
So there you have it. In S&P's view, the subindustry's price momentum still looks healthy, while the 12-month fundamental outlook also looks appealing.
Industry Momentum List Update
For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of December 2, 2005.
Construction & Engineering
Diversified Metals & Mining
Fertilizers & Agricultural Chemicals
Health Care Services
Managed Health Care
Oil & Gas Drilling
Oil & Gas Equipment & Services
Oil & Gas Exploration & Production
Oil & Gas Refining & Marketing
S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential vs. the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.
S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:
S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.
S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.
S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.
Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.
In the U.S.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 28.7% of issuers with buy recommendations, 60.3% with hold recommendations and 11.0% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.8% of issuers with buy recommendations, 44.8% with hold recommendations and 20.4% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 28.1% of issuers with buy recommendations, 51.1% with hold recommendations and 20.8% with sell recommendations.
As of September 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 29.3% of issuers with buy recommendations, 57.7% with hold recommendations and 13.0% with sell recommendations.
5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.
3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.
1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.
Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.
For All Regions:
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Stovall is chief investment strategist for Standard & Poor's